Early in your career is the perfect time to start a habit of saving for retirement because you have one huge advantage you'll never get again-time.
An employer-sponsored contribution retirement plan, such as a 401(k) or 403(b), works by you electing to have money automatically deducted from your paycheck on a pre-tax basis.
401(k) or 403(b)
- Try to save at least 10 percent pre-tax income in your plan, up to the limit the plan allows.
- If 10 percent is too much on a tight budget, a smaller percentage can still make a dramatic difference.
- If your employer matches your contributions, try to contribute at least enough to maximize the match-typically up to six percent of your salary.
- Saving six percent matching means you immediately double your savings.
- Don't cash out your 401(k) or other employer-sponsored plan when you change jobs. You'll pay income taxes and a penalty tax on the withdrawal. In addition, you'll lose the ability for the money to grow tax deferred. Roll it over into a self-directed retirement plan, such as an IRA, or transfer it to your new employer's retirement plan.
Please Note: If your employer offers a Roth 401(k), be aware that the employer's matches will be made with pre-tax dollars, but your contributions will be made with after-tax dollars.
A tax-deductible option is a traditional IRA. Through 2008, you can put up to $5,000 annually into one (up to $10,000 as a couple), with additional increases after that. Or, you currently can contribute up to $5,000 annually in after-tax dollars to a Roth IRA, with the advantage that earnings generally avoid taxation. In addition, you can put unlimited amounts into taxable investment accounts and start building your portfolio of stocks, mutual funds, annuities and other investments.
If you're self-employed, you have more tax-deferred choices. You can open a solo 401(k) plan, simplified employee pension (SEP), savings incentive match plan for employees (SIMPLE) or Keogh plan. You can find more information about these types of retirement plans at the IRS Web site (www.irs.gov).
What types of investments should you use for your retirement plan? That depends on several factors, including your tolerance for risk, your overall financial situation, job stability and so on. In general, however, most experts say that a younger age, you can probably afford to invest as aggressively as your comfort level allows. Dollar-cost averaging-investing the same dollar amount each month-is another way to build wealth over the long-term.